Glencore's business model has come back to haunt it

Volcanic
lightning or a dirty thunderstorm is seen above Shinmoedake peak
as it erupts, between Miyazaki and Kagoshima prefectures, in this
photo taken from Kirishima city and released by Minami-Nippon
Shimbun January 28, 2011.REUTERS/Minami-Nippon Shimbun

Glencore's astonishing collapse on Monday set it apart from other
mining companies. Anglo American, Rio Tinto and BHP Billiton all
tumbled too, but the scale of their decline was nowhere near as
large.

They're all suffering from the dramatic downturn in commodity
prices, but Glencore's exposure is comparatively enormous.

Here's what happens to different companies' earnings and earnings
per share when commodity prices move 10% either up or down —
which is essentially a barometer of how conservative the business
model is:

Macquarie

Glencore's earnings sensitivity to commodity prices is twice what
Rio Tinto's is, and its earnings per share are more than four
times as exposed.

In boom years, nobody complains about that — in fact,
shareholders at Rio Tinto might be a little disappointed at the
lower returns they see. But in a period of prolonged and largely
unexpected commodity price weakness like the one the world is
currently in, it's companies like Glencore that feel the heat.

Macquarie's analysts note that debt reduction plans announced
just three weeks ago are no longer sufficient:

Should market conditions fail to improve, GLEN’s credit metrics
would sit on the margin of BBB band and place the credit rating
at risk of a downgrade. Under these conditions, we estimate that
at least ~ $4bn of additional debt reduction initiatives would
need to be announced to reassure the ratings agencies and the
market that GLEN is committed to defending its BBB rating.

And the worse spot commodity prices get, the deeper those debt
reductions have to be. That means hacking away at investment
projects and selling assets. Here's how much Glencore would have
to flog just to break even if prices fell further:

Two charts from an Investec note on Monday show just what
that additional exposure means for the company's value. First,
here's what BHP Billiton, another FTSE 100 mining giant, looks
like if spot prices don't rise from here:

Investec

Investec's Hunter Hillcoat says that for BHP Billiton, "under
this scenario there is no increase in value for shareholders,
with debt holding steady at around one third of total value."

But that's quite different to the Glencore scenario:

Investec

For Glencore, Hillcoat says "Despite the drastic action that
management has announced recently (even assuming all of the
measures are successfully implemented), a spot price scenario
results in an almost complete collapse in forward earnings such
that no meaningful estimate of shareholder value can be
derived... the company is solely working to repay debt
obligations."

To be fair to Glencore, Hillcoat's analysis uses all of
Glencore's debt rather than its "net debt," which is much lower.
Net debt is the liabilities left over after the company has sold
its highly liquid inventory, which Glencore believes functions
like cash.

Nonetheless, Glencore's exposure was a choice, and something that
served it well during its boom years. But the whole business
model is about riding global commodity prices a little more than
its peers — and that's a ride that goes down as well as up.